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Financing the exercise of rights of first refusal

Most shareholders agreements allow shareholders to sell their shares, subject to certain rights granted to the other parties to the agreement. The recent Alberta case Zust Bachmeier International Air Cargo, Inc. v. Klapatiuk tested the limits of the right to sell in the context of the change of control of a closely-held, private company in Alberta. The case also highlights the fine line between improperly avoiding rights of first refusal and working assiduously to respect and not trigger them.

In this case, all of the shareholders of the company were party to a unanimous shareholders agreement (USA). The USA contained a right of first refusal (ROFR) stating that, if a shareholder desired to sell “all or any of his shares pursuant to a bonafide cash offer,” the remaining shareholders were entitled to buy those shares subject to the cash offer on the same terms. The USA also contained a buy/sell provision granting the usual ‘shotgun’ rights.

One group of shareholders, the McNally Group, wanted to sell its shares. The Richardson Group, which was not a shareholder, entered into an agreement with the McNally Group to acquire its shares. Zust, a shareholder and party to the USA, decided to exercise its rights under the ROFR to acquire its proportionate share of the McNally Group’s shares. The Richardson Group entered into an agreement with another shareholder, Klapatiuk, to fund his purchase of his proportionate share of the McNally Group’s shares.

The Richardson Group also agreed that, once the ROFR exercise was finished, they would again seek Zust’s consent to purchase shares from Klapatiuk. If Zust refused, Klapatiuk would trigger the shotgun (with the Richardson Group providing the funds if Klapatiuk had to buy) and then negotiate the sale of shares to the Richardson Group once Klapatiuk had full ownership of the company. Before the shotgun was used, Zust sued alleging conspiracy and interference with the exercise of Zust’s ROFR rights. Zust also alleged that the scheme triggered a further ROFR.

The action was dismissed in its entirety. The key element in this decision was the absence of any agreement between the Richardson Group and Klapatiuk for the purchase of shares. In short, no bonafide cash offer existed between them to purchase the company’s shares. All the Richardson Group had negotiated was an agreement with the McNally Group, which triggered the ROFR process between Zust and Klapatiuk, and a loan agreement with Klapatiuk. Klapatiuk was under no enforceable obligation to sell shares to the Richardson Group.

McCarthy Tétrault Notes:

A number of points arise from this decision to help guide similar transactions in the future.

In the absence of any provision in a USA or other similar agreement, parties to a USA are free to get funding from anyone in order to exercise their rights under the USA, including ROFRs, provided the loan terms do not offend the USA or other agreement.

The lender can intend and indeed desire to subsequently acquire, and the borrower can intend to sell, shares to be purchased with the loaned funds. However, the lender must not already have negotiated the terms and price of the subsequent purchase from the borrower/shareholder. While the point was not decided in this case, it may also be that the subsequent purchase agreement could be finalized provided it was subject to conditions precedent that ensure the other shareholders’ rights pursuant to the USA are preserved.

Setting out to intentionally avoid triggering a ROFR may be permissible. The plan created, however, must not result in a new entity having joint ownership of the company with a pre-existing entity against that preexisting entity’s will. Further, the plan, and conduct of the selling shareholder, must not render the rights of the other shareholders meaningless, as doing so may expose the acquiror to a claim for specific performance of the affected rights.

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